The Fed, Rogue Traders and the Markets
The stock market's January malaise turned into a global freefall as we in the U.S. celebrated the Martin Luther King Day holiday Monday, January 21. Analysts speculated a recession was already upon us, investors were starting to panic, and things looked pretty bleak as traders headed back to work Tuesday, January 22–until the Fed responded with a surprise cut of 75 basis points in the Federal funds rate. Then Wednesday, insurance regulators met with banks to devise a plan to provide financial assistance to bond insurers that back billions of dollars in debt. Our government also rushed to put together a $150 billion economic stimulus package, which is to include rebate checks to consumers to stimulate spending. The stock market responded, and things seemed to be calming down. The major market averages–the S&P 500, Dow Jones Industrial Average, and Nasdaq, skirted disaster last week.
Amid all the volatility last week, a new twist in the stock market story came to light. News emerged that the reasons behind the stock market's plunge might not have been lack of investor confidence amid the economic weakness. Some say a rogue trader at France's Société Générale may have turned a weak bear market into a roaring one.
A skilled computer hacker at the bank, Jerome Kerviel, had lost €4.9 billion, equal to $7.2 billion, through huge, unauthorized trades that he hid for months. News reports say the combined trading positions had totaled some €50 billion, or $73 billion. The French bank had to swiftly unwind the unauthorized trades over a short timeframe of about 72 hours, which many market participants now feel exacerbated the stock market's volatility Monday, and the resulting declines that rippled throughout markets globally.
So where does that leave us now? Some say the Fed had no knowledge of this rouge trader, and had been acting on what it thought were fundamental economic and financial issues. It begs the question, did they do the right thing in cutting rates so suddenly, and so far? On Tuesday, January 29, 2008, the Fed starts its regularly scheduled two-day Federal Open Market Committee meeting. The rogue trader news now raises new questions about what the Fed will do next. If the market did in fact sell off due to the liquidation of rouge trades, perhaps the Fed panicked unnecessarily with the pre-meeting rate cut. Where do we go from here? As of this writing, Federal funds futures are pricing in odds of more than 70 percent that the Fed will cut its key short-term rate again, by 50 basis points, to 3 percent.
S&P 500
For now, I'm recommending staying out of the market. I think the picture is too confusing. We've seen support hold off the lows in the S&P futures, but it could be short-lived. We'll have to wait and see. If you want to jump in for a long-term bullish position, I would recommend buying the March 2008 E-mini S&P 14.00 call for 21 points, at about $1,050 plus commission costs. The option expires on March 20. Cut your losses if the futures market trades below 12.50. You can buy a February E-mini S&P 12.50 put for 14.50, or about $750 plus commission costs.
Crude Oil
Crude oil had backed down from its all-time high the first of week of January above $100 a barrel amid talk of recession, and reduced demand potential that would likely bring. Crude oil futures hit a three-month low this week, but rebounded on speculation that the government's $150 billion economic stimulus package might allow the U.S. to skirt recession. The market is currently hovering around $90.
The economic picture is still far from certain at this point, and the market could remain pretty volatile. For a short-term trade, I'm recommending buying March NYMEX crude oil futures at $85.50, with a tight protective stop at $84.50. I am targeting a move up to $92.50. You might want to consider taking profits on the position before then if this trade gets triggered quickly, before the Fed meeting.
On the supply side, the latest data from the Energy Information Administration showed a built in crude oil and gas inventories, but heating oil and natural gas showed a draw. U.S. crude-oil inventories rose 2.3 million barrels to 289.4 million in the week ended Jan. 18, while gasoline supplies increased 5.1 million barrels to 220.3 million. I think the colder weather pushing through the Midwest and East is draining the heating oil supplies, and I see a short-term bounce to capitalize on. If recession isn't as a big a worry as it was, energy prices may rebound back to record levels, particularly if the Fed keeps cutting rates. Stay tuned for the action Wednesday–we'll see what the Fed has to say.
Richard Ilczyszyn is a Senior Market Strategist with Lind Plus. He can be reached at 800-605-0095or via email at rilczyszyn@lind-waldock.com.
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